It’s hard to date when exactly the financial crunch transformed into a full-fledged crisis, but a convenient starting point would be the bailout of Fannie Mae and Freddie Mac. It was at that point that it became abundantly clear that any chance of simply muddling through the credit crunch was not going to be possible. If the companies holding nearly 70% of America’s mortgages were on the verge of bankruptcy then just about any company might follow.
The Lehman Brothers bankruptcy followed closely the demise of Fannie and Freddie, and the AIG bailout came just a day after the government let Lehman fail.
Two things were made abundantly clear by this pattern of events: first, in the judgment of the Fed and Treasury our financial system was on the brink of collapse; and second, they had no plan for how to deal with the impending disaster. They were shooting from the hip, and that’s not a great way to aim.
It was signals sent by Washington that destroyed the underlying confidence that is the bedrock of any financial system. Investors, rationally viewing Washington’s actions, quickly rushed to the sidelines in order to wait and see what the government was going to do in order to clean up the mess.
Obviously it was going to do something—the bailout of Fannie, Freddie, and AIG all signaled that some action was imminent. The bankruptcy of Lehman ensured that nobody could guess what that something might be. The failure of Lehman was intended to signal that whatever was done, it would be limited. It’s pretty hard to make rational decisions when you have no idea what tomorrow’s market conditions might be.
If Washington was going to act—and it was telling everyone it would—is it too much to ask that it have a plan before doing so? The unpredictable nature of Washington’s words and actions helped create the crisis atmosphere that is hurting our economy today.
Washington has done nothing to calm the rattled nerves of investors since. In fact, it has made things much worse. Almost every single action and statement coming from Washington has added to both the uncertainty and anxiety that investors are feeling right now. What was a problem last year is a crisis today.
By pushing the panic button when they had no plan to deal with the crisis, the “wise men” in Washington have made things unimaginably worse than if they had done nothing at all. It may or may not in fact be the case that there was no palatable path out of this mess without massive government intervention—a proposition that splits respectable economists, even free market ones—but it is certainly clear that having the most senior economic and political officials in Washington screaming that the sky is falling has been a sure path to creating, not tamping down, a sense of crisis.
Unfortunately the die is almost certainly cast. Now that the crisis is upon us it is almost impossible to conceive of a path out without massive government intervention. The whole world is waiting to see what Washington does, and until it acts in some decisive fashion markets will be in turmoil.
Washington now needs to buttress the confidence in our financial system that it has helped undermine. We can only hope that the policies they choose prove a lot more successful than the ones chosen in the 1930s.